taxes chapter 8 when you have completed your study of this chapter, you will be able to c h a p t e...

47

Upload: evan-little

Post on 17-Jan-2016

216 views

Category:

Documents


0 download

TRANSCRIPT

Page 1: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices
Page 2: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Taxes CHAPTER8

Page 3: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

When you have completed your study of this chapter, you will be able to

C H A P T E R C H E C K L I S T

Explain how taxes change prices and quantities, are shared by buyers and sellers, and create inefficiency.

1

Explain how income taxes and Social Security taxes change wage rates and employment, are shared by employers and workers, and create inefficiency.

Review ideas about the fairness of the tax system.

2

3

Page 4: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Tax Incidence

Tax incidence

The division of the burden of a tax between the buyer and the seller.

When a good is taxed, it has two prices:• A price that includes the tax• A price that excludes the tax

Buyers respond to the price that includes the tax.

Sellers respond to the price that excludes the tax.

Page 5: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

The tax is like a wedge between the two prices.

Suppose that the government puts a $10 tax on MP3 players.

How does the price that buyers pay change?

How does the price sellers receive change?

How is the burden of a tax shared between the buyer and the seller?

Page 6: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

1. With no tax, the price is $100 and 5,000 players a week are bought.

2. A $10 tax on buyers of MP3 players shifts the demand curve to D – tax.

Figure 8.1(a) shows what happens when the government taxes buyers of the MP3 players.

Page 7: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

3. The price paid by buyers rises to $105—an increase of $5 a player.

4. The price received by sellers falls to $95—a decrease of $5 a player.

5. The quantity decreases to 2,000 players a week.

6. The government’s tax revenue is $20,000 a week.

Page 8: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

1. With no tax, the price is $100 and 5,000 players a week are bought.

2. A $10 tax on sellers of MP3 players shifts the supply curve to S + tax.

Figure 8.1(b) shows what happens when the government taxes sellers of the MP3 players.

Page 9: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

3. The price paid by buyers rises to $105—an increase of $5 a player.

4. The price received by sellers falls to $95—a decrease of $5 a player.

5. The quantity decreases to 2,000 players a week.

6. The government’s tax revenue is $20,000 a week.

Page 10: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

A tax places a wedge between the buyers’ price (marginal benefit) and the sellers’ price (marginal cost).

The equilibrium quantity is less than the efficient quantity and a deadweight loss arises.

Taxes and Efficiency

8.1 TAXES ON BUYERS AND SELLERS

Page 11: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

In Figure 8.2(a), the market is efficient with marginal benefit equal to marginal cost.

Figure 8.2 shows the inefficiency of taxes.

8.1 TAXES ON BUYERS AND SELLERS

Total surplus—the sum of2. Consumer surplus and3. Producer surplus—is maximized.

Page 12: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

A $10 tax shifts the supply curve to S + tax.

3. Consumer surplus and4. Producer surplus shrink.

Figure 8.2(b) shows how taxes create inefficiency.

5. The government collectsits tax revenue.

6. A deadweight loss arises.

1. Marginal benefit exceeds 2. Marginal cost.

8.1 TAXES ON BUYERS AND SELLERS

Page 13: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

The loss of consumer surplus and producer surplus is the burden of the tax.

8.1 TAXES ON BUYERS AND SELLERS

The burden of the tax equals the tax revenue plus the deadweight loss.

Page 14: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Excess burden

The deadweight loss from a tax—the amount by which the burden of a tax exceeds the tax revenue received by the government.

8.1 TAXES ON BUYERS AND SELLERS

The excess burden is $15,000.

(3,000 $10 2)

Page 15: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Incidence, Inefficiency, and Elasticity

The incidence of a tax and its excess burden depend on the elasticites of demand and supply:

• For a given elasticity of supply, the buyer pays a larger share of the tax the more inelastic is the demand for the good.

• For a given elasticity of demand, the seller pays a larger share of the tax the more inelastic is the supply of the good.

8.1 TAXES ON BUYERS AND SELLERS

Page 16: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Tax Incidence and Elasticity of Demand

Perfectly Inelastic Demand: Buyer Pays and Efficient

Perfectly Elastic Demand: Seller Pays and Inefficient

Figures 8.3(a) and 8.3(b) illustrate these two extreme cases.

Page 17: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Figure 8.3(a) shows tax incidence in a market with perfectly inelastic demand—the market for insulin.

A tax of 20¢ a dose raises the price by 20¢, and the buyer pays all the tax.

Marginal benefit equals marginal cost, so the outcome is efficient.

Page 18: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Figure 8.3(b) shows tax incidence in a market with perfectly elastic demand—the market for pink pens.

A tax of 10¢ a pink pen lowers the price received by the seller by 10¢, and the seller pays all the tax.

A deadweight loss arises, so the outcome is inefficient.

Page 19: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Tax Incidence, Inefficiency, and Elasticity of Supply

Perfectly Inelastic Supply: Seller Pays and Efficient

Perfectly Elastic Supply: Buyer Pays and Inefficient

Figures 8.4(a) and 8.4(b) illustrate these two extreme cases.

Page 20: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Figure 8.4(a) shows tax incidence in a market with perfectly inelastic supply—the market for spring water.

A tax of 5¢ a bottle does not change the price paid by the buyer but lowers the price received by the seller by 5¢.

Marginal benefit equals marginal cost, so the outcome is efficient.

The seller pays the entire tax.

Page 21: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.1 TAXES ON BUYERS AND SELLERS

Figure 8.4(b) shows tax incidence in a market with perfectly elastic supply—the market for sand.

A tax of 1¢ a pound increases the price by 1¢ a pound, and the buyer pays all the tax.

A deadweight loss arises, so the outcome is inefficient.

Page 22: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

In 2004, the personal income tax raised:•More than $1 trillion for the federal government•About $300 billion for state and local governments

The amount of income tax that a person pays depends on her or his taxable income and on the tax rates.

Taxable income

Total income minus a personal exemption and a standard deduction (or other allowable deductions).

The Personal Income Tax

Page 23: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Marginal tax rate

The percentage of an additional dollar of income that is paid in tax.

Average tax rate

The percentage of income that is paid in tax.

Page 24: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

A tax can be progressive, proportional, or regressive.

Progressive tax

A tax whose average rate increases as income increases.

Proportional tax

A tax whose average rate is constant at all income levels.

Regressive tax

A tax whose average rate decreases as income increases.

THE TAX SYSTEM8.2 INCOME AND SOCIAL SECURITY TAX

Page 25: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Figure 8.5 shows U.S. tax rates in 2001.

1. Marginal tax rate increases with income.

2. Average tax rate increases with income

The personal income tax is a progressive tax.

Page 26: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Tax on Labor Income

Firms can substitute machines for labor, so the demand for labor is elastic.

Most people must work for their income, so the supply of labor is inelastic.

With elastic demand and inelastic supply, the worker bears the greater burden of the income tax.

8.2 INCOME TAX AND SOCIAL SECURITY TAX

The Effects of the Income Tax

Page 27: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Figure 8.6 shows the effects of a tax on labor income.

4. A deadweight loss arises.

With a 20% income tax:

2. The employer pays some of the tax.

3. The worker pays most of the tax.

1. The supply of labor decreases, the wage rate rises, and the after-tax wage rate falls.

Page 28: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Taxes on Capital Income

Taxing the income from capital works like taxing the income from labor.

One crucial difference: capital is internationally mobile and so the supply of capital is highly elastic—perhaps perfectly elastic.

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Page 29: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Figure 8.7 shows the effect of a tax on capital income.

1. The supply of capital is perfectly elastic.

2. With a 40 percent tax on capital income, the interest rate rises.

3. The firm pays the entire tax.

4. A large deadweight loss arises.

Page 30: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Taxes on Income from Land and Unique Resources

Works in the same way as taxing the income from other sources except for one crucial difference.

The supply of land is highly inelastic.

The tax on land income is fully borne by the landowners and the quantity of land is unaffected by the tax.

With no change in the quantity of land, the tax on land income creates no deadweight loss or excess burden and is efficient.

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Page 31: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Figure 8.8(a) shows a tax on income from land.

1. Supply is perfectly inelastic.

2. With a 40 percent tax, the supply of land is unchanged and the market rent is unchanged.

3. The landowner pays the entire tax.

No deadweight loss arises—the tax is efficient.

Page 32: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

Figure 8.7 (b) shows a high tax rate on Barbara Walter’s income.

1. Supply is perfectly inelastic.

2. With a 40 percent tax, the supply curve is unchanged and the market price is unchanged.

3. Barbara Walters pays the entire tax.

No deadweight loss arises and the tax is efficient.

Page 33: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

The Social Security Tax

The Social Security tax law says that the tax is to be shared equally by workers and employers.

But the principles that determine the incidence of other taxes you’ve studied in this chapter also apply to the Social Security tax.

We look at two extreme Social Security taxes: one on workers only and one on employers only.

Page 34: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

With no taxes, the wage rate is $6.00 an hour and 4,000 people are employed.

1. A 20 percent Social Security tax on workers shifts the supply curve to LS + tax.

A Social Security Tax on Workers

Page 35: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

2. The wage rate paid by employers rises to $6.25 an hour—an increase of 25 cents an hour.

3. The number of people employed decreases to 3,000.

4 Workers receive $5 an hour—a decrease of $1 an hour.

Page 36: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

5. The government collects tax revenue shown by the purple rectangle.

Workers pay most of the tax because the supply of labor is more inelastic than the demand for labor.

Page 37: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME AND SOCIAL SECURITY TAX

A Social Security Tax on EmployersPayroll tax

A tax on employers based on the wages they pay their workers.

Figure 7.4 on the next slide shows the effects of a payroll tax.

Page 38: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

With no tax, the wage rate is $6.00 an hour and 4,000 people are employed.

1. A tax on employers of $1.25 an hour shifts the demand curve to LD – tax.

A Social Security Tax on Employers

Page 39: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

2. The wage rate falls to $5.00 an hour—a decrease of $1.00 an hour.

3. The number of workers employed decreases to 3,000.

Page 40: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

8.2 INCOME TAX AND SOCIAL SECURITY TAX

4. Employers’ total cost of labor rises to $6.25 an hour—the $5.00 wage rate plus the $1.25 payroll tax.

5. The government collects tax revenue shown by the purple rectangle.

Page 41: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Whenever political leaders debate tax issues, it is fairness, not efficiency, that looms above all other considerations.

There are two conflicting principles of fairness of taxes:• The benefits principle• The ability-to-pay principle

8.3 FAIRNESS AND THE BIG TRADEOFF

Page 42: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

The Benefits Principle

Benefits principle

The proposition that people should pay taxes equal to the benefits they receive from public goods and services.

This arrangement is fair because it means that those who benefit most pay the most.

But to implement it, we would need an objective way of measuring each person’s marginal benefit from public goods and services.

8.3 FAIRNESS AND THE BIG TRADEOFF

Page 43: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

The Ability-to-Pay Principle

Ability-to-pay principle

The proposition that people should pay taxes according to how easily they can bear the burden.

A rich person can more easily bear the burden of providing public goods than a poor person can, so the rich should pay higher taxes than the poor.

This principle compares people according to• Horizontal equity• Vertical equity

8.3 FAIRNESS AND THE BIG TRADEOFF

Page 44: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Horizontal equity

The requirement that taxpayers with the same ability to pay the same taxes.

Vertical equity

The requirement that taxpayers with a greater ability to pay bear a greater share of the taxes.

8.3 FAIRNESS AND THE BIG TRADEOFF

Page 45: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

The Marriage Tax Problem• In the U.S. tax code, a married couple is

considered a single taxpayer. • This arrangement means that if they each earn the

same income as before a marriage, the married couple might pay more tax than they did before marriage.

8.3 FAIRNESS AND THE BIG TRADEOFF

Page 46: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

The Big Tradeoff

Questions about the fairness of taxes conflict with efficiency questions and create the big tradeoff.

Taxes on capital incomes create the greatest deadweight loss—are the most inefficient.

But most of the capital is owned by a small number of rich people, so (most people believe) taxes on capital are the fairest.

Our tax system is an evolving attempt to juggle to two goals of efficiency and fairness.

8.3 FAIRNESS AND THE BIG TRADEOFF

Page 47: Taxes CHAPTER 8 When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Explain how taxes change prices

Taxes in YOUR LifeThe Tax Foundation has calculated “Tax Freedom Day”—the day by when the average U.S. citizen has worked longenough to pay a year’s tax bill.

In 2004, Tax Freedom Day was 17 April—107 days:• 38 days to pay personal income taxes • 30 days to pay Social Security taxes• 16 days to sales and excise taxes• 11 days to pay property taxes• 9 days to pay corporate income taxes• 3 days to pay all other taxes

Work out your own “Tax Freedom Day.”